Why Long-Short is the New Long g Presentation P t ti to t PortfolioConstruction P tf li C t ti Conference 2008 Vasant Khilnani – Senior Portfolio Manager g Paul Sewell – General Manager – Equity Sales August 2008 Is this a Normal Market? 16000 Dow Jones Industrial Average 14000 12000 10000 8000 6000 4000 2000 0 Source: IRESS 1 Or is this a Normal Market? 1200 Dow Jones Industrial Average 1000 800 600 400 200 0 Source: IRESS 2 Implications for Investors Need to run p portfolio more efficiently y 3 – Extract high return for same risk – Lower risk for same returns Clarke, Silva & Thorley O t b 2002 October Alpha p = TE * IC * TC * N^.5 Where Alpha = Excess Return Desired by the investor TE = Tracking error or risk in the portfolio IC = Managers skill. It is his/her ability to forecast returns for individual stocks TC = Transfer coefficient of the portfolio N = Market breadth or number of independent bets in the portfolio 4 Ingredients for Alpha Alpha = TE * IC * TC * N N^.5 .5 An increase in the left hand side of the equation (Alpha) (Alpha), can be achieved by increasing any of the terms on the right hand side. In I absence b off any portfolio tf li constraints, t i t TC = 100 5 How inefficient is the long only constraint? Clarke, De Silva, Sapra - 2004 Constraints Removed All Constraints Transfer Coefficient (TC) % Change in TC 6 0.332 Position Market Long Limit Cap Only 0.346 0.298 0.471 0.678 8% -7% 46% 108% Industry Sector 0.347 8% Australian Context Up Month September 2007 Down Month January 2008 7 Portfolio Tracking Error Efficiency (TC) % Change in efficiency (TC) Long Only 3 75.64% 5% Short 3 83.42% 10.29% 10% Short 3 86 46% 86.46% 14 30% 14.30% 15% Short 3 88.38% 16.84% 20% Short 3 90.36% 19.46% P tf li Portfolio T Tracking ki Error E Effi i Efficiency (TC) % Ch Change iin efficiency ffi i (TC) Long Only 3 81.23% 5% Short 3 92.48% 13.85% 10% Short 3 94.83% 16.74% 15% Short 3 96.09% 18.29% 20% Short 3 97.08% 19.51% Tracking error 3% was chosen as it is typical of an active manager in Australia Max number of stocks 100 Position limits: starting at ±5% for the rank 1 stock and then linearly reducing to ±0.5% ±0 5% Universe: ASX 300 Transaction costs were ignored What is Implied Alpha? Not explicitly p y supplied pp by y the p portfolio manager g Implied by the manager’s manager s portfolio 8 An Implementation Case Study Can an existing g Long-only g y process p benefit from Long-Short g strategy? gy – Super imposed short positions – Long Investment process untouched – Implied alphas used – Done 6 years ago 9 Back Test Methodology Long positions same as ASF Monthly Rebalance Use of Implied Alphas for short positions Æ 10 Share Plus = 120% ASF + 20% Short Positions Back testing of Long only Vs Long-Short Portfolio August 1997 - August 2002 Long Only Long Short Benchmark return p.a. 7.41% 7.41% Portfolio Return p.a. 12.05% 17.55% Active Return p.a. 4.64% 10.14% Active Risk (TE) 4.29% 6.17% 1.08 1.64 51.90% 12.13% 12.26% 1.07% Information Ratio (IR) Absolute Risk (Risk of losing money or beta risk) 11 Change Some implementation considerations for Short Selling strategies t t i Risks – Risks in the short position are skewed Stock Availability for short selling – In Australia, most if not all short positions are implemented by borrowing stock from a prime broker Franking F ki credits dit – Domestic Vs Overseas Lenders 12 Conclusion Not running a portfolio at its maximum possible efficiency is like driving a six speed car in second gear. The short positions are inherently more risky than long positions but the risk can be managed. Even a modest amount of short selling g can have dramatic impact p on the portfolio efficiency. 13 Questions and Answers 14 The Plus in SHARE-PLUS (ASF 20%) ASF (+20%) ASFASF 100% 100% Non ASF N -(20%)(- 15 SHARE-PLUS Performance J June 2003 tto JJune 2008 16 ASF Share-Plus Benchmark Excess 12 Months to June ‘04 04 24 77% 24.77% 25 79% 25.79% 21 75% 21.75% +4 04% +4.04% 12 Months to June ‘05 27.63% 25.20% 26.04% -0.84% 12 Months to June ‘06 25.77% 24.91% 24.01% +0.90% 12 Months to June ‘07 24.28% 22.68% 29.20% -6.52% 12 Months to June ‘08 -9.62% -4.89% -13.67% +8.78% Key messages Not hedge fund – core equity product Leverages off our stock picking skills Risks similar to traditional equity products 17 Disclaimer IMPORTANT NOTE: This presentation has been prepared by Perpetual Investment Management Limited ABN 18 000 866 535 535, an Australian Financial Services Licensee, Licence Number 234426, a subsidiary of Perpetual Trustees Australia Limited. While Perpetual strives to provide accurate information, this presentation should not be treated as a comprehensive statement of any law or practice. This presentation is not intended to provide you with personal advice and in providing this information, we have not taken into account your particular investment objectives, financial situation or needs. You should assess whether this information is appropriate for your particular needs, either by yourself or with your adviser. Perpetual expressly disclaims any responsibility or liability to anyone who acts or relies upon anything contained in, or omitted f from, this thi presentation. t ti T Total t l returns t shown h iin th the presentation/slides t ti / lid h have b been calculated l l t d using i exit it prices i after ft ttaking ki iinto t accountt allll off Perpetual’s ongoing fees and assuming reinvestment of distributions. No allowance has been made for taxation. Past performance is not indicative of future performance. 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